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ZEE–Sony deal – a positive push?

Deal contours

* The post-money merger ratio is 47.07% for Zee Entertainment (Z) and 53.93% for Sony Pictures Network Ltd (SPNI). On a pre-money basis (excluding the USD1.6b equity infusion by SPNI), the merger ratio would be 61.25% for Z and 38.25% for SPNI.

* At Z’s current market cap, this implies post-money enterprise value of INR697b for the merged entity and INR369b for SONY (as it is an unlisted company). Alternately, valuing the incremental stake of 14.18% at INR113.4b, the implied value of the merged entity works out to INR800b.

* Adjusted for the USD1.575b equity infusion by SPNI, the pre-money enterprise value of SPNI works out to INR270b, i.e., EV/EBITDA and P/E of 19x and 31x, respectively, on an FY20 basis

Deal process

* Z's shareholders and creditor approval – The company needs approval from three-fourths of the shareholders. Given that the institutional ownership is 75% in the company, and the promoter group holds merely 4%, it would be important to build a consensus on the deal.

* MIB and CCI approvals – The management indicated an overall deal timeline of 7–8 months; however, historically, deals in the Media industry have not been swift.

What is in it for each stakeholder?

* Promoter: This is a White Knight situation for the promoter group, which would be able to maintain management control of the company.

* Z, the company:

* Strategically, the merger of the two entities is a reasonably fair fit as the combined entity – with combined market share of ~27% v/s Star’s 24% – would have a wider portfolio across genres, including general entertainment, movies, and sports. SPNI (a unit of Japan’s Sony Corp) operates 26 channels, including sports channels, and Z has 49 channels. Over time, the company could use this leverage to drive competitive position and synergies.

* But as the devil’s advocates, we are left with one question: what does Sony bring to the table – given that Z has strong capabilities in terms of content generation, execution, and reach? Well, there could be a significant upside opportunity from Sony’s performance improvement and synergies in the merged entity.

* SONY: Sony gains in two primary aspects: a) It acquires business at a reasonable price. Z, despite the rally, is valued at P/E of ~20x on a one-year forward basis – if we assume margins would stabilize over time – which is a far cry from its peak valuation of over 30–35x. b) Furthermore, Sony gains a strong leadership team with a strong track record to drive the Broadcasting business – considering Z’s industry-leading performance over the last several years.

* Non-Promoter:

Scenario 1: Non-promoters (read Invesco) may not back the deal for two reasons:

* Punit Goenka remains the MD and CEO: Yes, the new entity would see a change in the board, which would be elected by the SONY group. However, Punit Goenka continuing as MD and CEO of Z may still not break the ice – given that Invesco had recently requested an EGM for his removal.

* Overlapping portfolio; limited fresh capabilities: Z already has a strong track record of execution, content generation capabilities, and reach.

* Scenario 2:

* Strong board; resolution to corporate governance overhang: The Z board would get a complete overhaul, overseen by SONY’s board, along with a senior management team (current MD: Punit Goenka) with a very strong track record of performance.

* Synergies between two strong companies: There is potential for an upside from the merged entity’s higher competitive position in the market and synergy gains – given that both the companies have significant potential to improve profitability.

Valuation and view

The stock, despite the rally in the last couple of weeks, is still trading at ~20x. Assuming the EBITDA margin would normalize closer to previous levels, improving corporate governance and operational performance could significantly aid in the long run. However, it would be some time before the deal reaches fruition and we see structural changes to the business, board, and leadership. Thus, the stock may trace key milestones of the deal and operational performance. For now, we maintain a Neutral rating with revised TP of INR320, valuing Z at 23x FY23E EPS. We see a significant upward earnings bias on an improving margin profile.

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